Some think it is still right to play safer with the advanced markets, fearing more damage to the emerging world from slowdowns and recessions. Some worry that the stronger dollar and high interest rates that have followed from Federal Reserve (Fed) tightening could damage economic activity and make debt servicing and refinancing expensive.
Others think emerging markets were hit enough in the bear market of 2022 and now merit a second look ahead of peak Fed rates and a possible economic recovery in 2024. In practice, emerging markets performed differently from each other last year. China was weak as it was still experiencing Covid-19 lockdowns and trade troubles with Washington. In contrast, aa strong India saw faster growth.
The MSCI Emerging Markets Index has a 32% weighting to China, India is at 14%, with Taiwan 14%, Korea 11%, Brazil 5% and Saudi Arabia 4%. It is an index with a couple of developed countries with relatively high GDP per head appended to the two faster growing giants of China and India.
In our recent reviews of China, we drew attention to the short-term prospects for a better growth year as policy tilts dramatically toward a reopening narrative away from its ‘zero-Covid’ policy. We also pointed out that the longer-term trend towards more government interference and control, and the continuing trade and technology war with the US would put many Western investors off. India has become preferred by many despite its high valuation, offering a faster growth rate from a lower base and more observance of Western rules of commerce and investment.
Politics and Brazil
Brazil is the next biggest economy in the emerging markets grouping, and the largest by far in Latin America. It has debt and inflation issues, due to the relatively high current level of spending and the impulses of the new President Lula da Silva to spend more. Since coming to office, President Lula has moved quickly to boost social spending and has questioned the 3.25% central bank inflation target.
Finance minister Fernando Haddad has tried to reassure markets that the central bank will stick with the old target and will do what it takes to curb inflation, currently at 5.77%. He has tried to produce a budget with falling borrowing needs based mainly around proposed higher tax revenues. Not all of these may materialise as he seeks to get more tax out of business and rich individuals.
There are expectations of added government intervention in the oil company, Petrobas, with planned reversals of some of Bolsonaro’s general economic liberalising moves. So far this year, the stock market has failed to join the January equity-market rally, whilst ten-year bonds have been stable, with yields around 13% compared to a low of 11.6% last September.
Looking at emerging market economies by GDP, China is dominant followed by a small clutch of countries with GDP above the $1 trillion threshold. These are led by India, Brazil, Russia, Mexico and Indonesia. After Turkey, the next largest is Thailand, with GDP at under $500bn. If we look at PPP GDP then China and India dominate, followed by Brazil, Indonesia, Turkey and Mexico. Neither China nor India on current policy seem to want to test market tolerance of excess debt, though India in the long run-up to election will not be shy about borrowing.
There may well be individual markets with opportunities for decent returns from here.
The main worries of those who fear debt turbulence in emerging markets relate to smaller economies, where the country is not an important part of world GDP nor significant in world indices.
The troubles of Sir Lanka are well known, where there is an International Monetary Fund (IMF) facility and programme in active discussion. Ukraine is worrying but, so far, the World Bank, IMF and Western countries have been willing to lend and grant money as well as weapons. The countries with the most exposed ratios of debt interest to gross national income according to the World Bank include Angola, Mozambique, Lebanon, Mauritius, Montenegro, Belize, El Salvador, Kazakhstan, Papua, Armenia and Georgia. Eastern Europe close to Russia is also a pressure point.
If we look at political risk, then Turkey rates highly as it has a government that is ignoring inflation in the pursuit of growth. Russia, following an aggressive war that inflicts some self-harm with huge damage to Ukraine and some to the smaller countries nearby, is a permanent worry.
Overall, the ratio of state debt to GDP for the emerging economies is 64% (end 2021, IMF) compared to almost twice as much for advanced countries and a world average of 95.7%. Private sector debt is usually higher, with EMs averaging 192% of GDP. These average figures make emerging markets an investment menu where there may well be individual markets with opportunities for decent returns from here. The nature of the indices means you are placing an Asian bet, with China in the lead role, if you go for an index tracker or a general emerging market fund, so it’s important to check what holdings these investments have.
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